The last time the United States came dangerously close to defaulting on its debt, a Democratic president and a Republican Speaker of the House of Representatives struck a deal to raise the country’s borrowing limit and curb growth in federal spending on firmly under control in the coming years. The deal avoided bankruptcy, but hindered what was already a slow recovery from the Great Recession.
The debt deal that President Biden and Chairman Kevin McCarthy agreed to is less restrictive in principle than that of President Barack Obama and Chairman John Boehner in 2011, focusing on just two years of budget cuts and spending caps. The economy that will absorb those cuts is in much better shape. As a result, economists say, the deal is unlikely to do the kind of lasting damage to the recovery that was caused by the 2011 debt ceiling agreement — and, paradoxically, the renewed spending restraint could actually contribute to that.
“For months I worried about the major economic fallout from the negotiations, but the macro impact seems negligible at best,” said Ben Harris, a former deputy secretary of the treasury for economic policy who left his post earlier this year.
“The main impact is the stability that comes with having a deal,” Mr Harris said. “Markets can function in the knowledge that a catastrophic debt ceiling crisis is not imminent.”
Mr Biden expressed confidence earlier this month that a deal would not trigger an economic downturn. That was in part because growth continued over the past two years, even as pandemic aid spending wound down and total federal spending fell from elevated Covid levels, reducing the annual deficit by $1.7 trillion last year.
When asked at a press conference at the Group of 7 summit in Japan this month whether budget deal cuts would trigger a recession, Mr Biden replied, “I know they won’t. I know they won’t. The fact that we were able to cut government spending by $1.7 trillion did not trigger a recession. That led to growth.”
The agreement in principle still has to go through the House and Senate, where it faces opposition from the most liberal and conservative members of Congress. It goes well beyond spending limits, including new work requirements for food stamps and other government aid and an effort to speed up permitting for some energy projects.
But the centerpiece is the limitation of spending. Negotiators agreed to slightly cut discretionary spending – outside of defense and veterans’ care – from this year to next year after accounting for some accounting adjustments. Spending on military and veterans would rise this year to the amount called for in Mr. Biden’s fiscal year 2024 budget. All those programs would grow 1 percent in fiscal year 2025, which is less than expected.
An analysis of the proposal by the New York Times suggests it would cut federal spending by about $55 billion next year, compared to the Congressional Budget Office projections, and by another $81 billion by 2025.
The first back-of-the-envelope analysis of the deal’s economic fallout came from Mark Zandi, an economist at Moody’s Analytics. He had previously estimated that a prolonged bankruptcy could cost the US economy seven million jobs — and that a deep round of proposed Republican cuts would kill 2.6 million jobs.
His analysis of the emerging deal was much more modest: The economy would have 120,000 fewer jobs by the end of 2024 than without the deal, he estimates, and the unemployment rate would be about 0.1 percent higher.
Mr Zandi wrote on Twitter on Friday that it was “not the best timing for fiscal restraint as the economy is fragile and recession risks are high.” But, he said, “it’s manageable.”
Other economists say the economy could use a mild dose of fiscal austerity right now. The biggest economic problem is the persistent inflation, which is partly driven by strong consumer spending. Taking some federal spending out of the economy could help the Federal Reserve, which is trying to control price growth by raising interest rates.
“From a macroeconomic perspective, this deal is a little help,” said Jason Furman, a Harvard economist who served as deputy director of Obama’s National Economic Council in 2011. rates to achieve that cooling.”
“I think the Fed will welcome the help,” he said.
Economists generally view increased government spending as a short-term boost to the economy if not offset by higher tax revenues. That’s because the government borrows money to pay salaries, buy equipment, cover health care, and provide other services that ultimately support consumer spending and economic growth. This can especially help boost the economy at times when consumer demand is low, such as the immediate aftermath of a recession.
That was the case in 2011, when Republicans took control of the House and forced a showdown with Obama over raising the borrowing limit. The nation slowly climbed out of the hole left by the 2008 financial crisis. The unemployment rate was 9 percent. The Federal Reserve had cut interest rates to near zero to stimulate growth, but many liberal economists called on the federal government to spend more to stimulate demand and accelerate job growth.
The budget deal between the Republicans and Mr. Obama — which was endorsed by Mr. Biden, who was then vice president — did the opposite. It cut federal discretionary spending by 4 percent in the first year after the deal compared to baseline projections. In its second year, it cut spending by 5.5 percent compared to projections.
Many economists have since blamed those cuts, along with too little stimulus spending at the start of the recession, for continuing the pain.
The deal announced on Saturday includes smaller cuts. But the even bigger difference today is the economic conditions. The unemployment rate is 3.4 percent. Prices are rising at more than 4 percent a year, well above the Fed’s target rate of 2 percent. Fed officials are trying to cool economic activity by making it more expensive to borrow money.
Michael Feroli, a JPMorgan Chase analyst, wrote this week that the proper way to judge the impending deal was in terms of “how much less work the Fed has to do to contain aggregate demand as the fiscal belt tightens.” now doing that work.” Mr Feroli estimated the deal could function as the equivalent of a quarter-point increase in interest rates, in terms of helping to curb inflation.
While the deal will have only a modest impact on the country’s future deficit levels, Republicans have argued it will help the economy by reducing debt buildup. “We are trying to bend the government cost curve for the American people,” North Carolina Representative Patrick T. McHenry, one of the Republican negotiators, said this week.
Still, the deal’s spending cuts will affect non-defense discretionary programs, such as Head Start kindergarten, and the people they serve. New job demands could choke out food and other aid to vulnerable Americans.
Many progressive Democrats warned this week that those effects will amount to their own kind of economic damage.
“After inflation eats its share, flat financing will result in fewer households accessing rent assistance, fewer children in Head Start, and fewer services for senior citizens,” said Lindsay Owens, the executive director of the liberal Groundwork Collaborative in Washington.
Catie Edmondson reporting contributed.
